Real Estate Secondaries: Market Trends You Should Capitalize On

Rather than being hypnotized by trophy assets in primary markets, commercial real estate investors might be better off looking at opportunities in secondary markets. Secondary markets represent some of the fastest-growing markets of any size in the country. One of the reasons: Many Americans are seeking lower-cost places to live and do business, yet they still want to enjoy big-city-style amenities.

Are Secondaries a Good Investment?

Secondary real estate markets can be good investments. A key reason is that some of the highest-growth markets in the country are classified as secondary, and secondary markets are attracting folks in search of low-cost locales to live and work. Pricing and barriers to entry also figure into the equation.

Factors that go into defining commercial real estate markets include population and transaction volume. Generally, a primary market is home to at least 5 million people, while the population of a secondary market is 2 million to 5 million, and a tertiary market is home to less than 2 million residents.

But these are loose definitions. For instance, Atlanta falls into the primary bucket in some cases but the secondary bucket in others.

Examples of popular secondary markets (and some of the fastest-growing commercial real estate markets) include:

• Austin, Texas
• Charlotte, North Carolina
• Nashville, Tennessee

As evidence of the value of investing in secondary markets, the Urban Land Institute and professional services provider PwC recently issued a report ranking Nashville as the country’s No. 1 real estate market for 2023, with Austin landing at No. 4 and Charlotte at No. 10. Nashville catapulted to the top based on its attractive investment prospects in the multifamily, industrial, hotel and retail sectors.

Some tertiary markets also are popular among commercial real estate investors. These include Charleston, South Carolina; Omaha, Nebraska; and Raleigh, North Carolina.

What Are the Advantages of a Secondary Market?

Secondary real estate markets offer a number of advantages for real estate investors. Here are three of them.

1. Potentially Better ROI

Because of the possibility of higher cap rates, secondary markets hold the potential to generate a higher return on investment than primary markets.

It’s worth noting, however, that in 2022, cap rates in some secondary markets have crept closer to those in primary markets. For instance, average underwritten multifamily cap rates in secondary markets like Austin and Nashville are gaining ground on those in primary markets like New York City.

2. Less Competition

Secondary markets tend to attract less competition for assets than primary markets do. Therefore, assets in secondary markets might be cheaper than assets in primary markets. That helps reduce a big barrier to entry.

However, stepped-up competition is coming from foreign investors. A 2022 survey by the Association of Foreign Investors in Real Estate (AFIRE) found that 71% of foreign investors planned to boost investment in secondary U.S. markets over the next three to five years, and 63 percent planned to boost investment in tertiary U.S. markets. Meanwhile, just 32% planned to boost investment in gateway markets in the U.S. over the next three to five years.

3. High Growth

Robust population and economic gains help drive an area’s growth. And many secondary markets fit into the high-growth category. They include:

• Austin, whose population rose 14.6% from 2015 to 2020.
• Orlando, Florida, whose population jumped 10.5% from 2015 to 2020.
• Las Vegas, whose population climbed 10.4% from 2015 to 2020.

Strong growth contributes to less market volatility, making secondary markets an attractive option for real estate investors.

Why are Secondary Real Estate Markets Growing?

One reason real estate investors are chasing deals in secondary markets centers on a single word: yield. Low yields are driving some investors toward these markets thanks to the favorable cap rates.

The data bears out these and other secondary market trends. Statistics from CoStar show transaction volume in secondary markets rose 14% from 2019 to 2021. In tertiary markets, the growth rate was 10%. But in primary markets, transaction volume dropped 18%. At the same time, the cap rate gap separating secondary and tertiary markets from primary markets is narrowing.

Another trend that’s propelling interest in secondary market real estate is tied to the COVID-19 pandemic. The pandemic pushed many investors away from primary markets and toward lower-priced secondary and tertiary markets. In part, this shift is taking place because some observers believe primary markets will be hit harder by the rise of working from home than other markets.

Furthermore, many secondary markets enjoy a higher quality of life and a better business environment than their primary counterparts.

How Is Price Decided in a Secondary Market?

As is the case with so many purchases, the price of a property in a secondary market depends in large part on supply and demand. When comparing properties in different secondary markets, examining the cap rates will go a long way toward determining whether an asset is worth purchasing or not.

If you’re looking to buy a multifamily property in a highly desirable secondary market like Nashville, for instance, you might get less bang for your buck than you’re planning to buy a multifamily property in a not-as-hot secondary market like St. Louis. However, because the price for a comparable property likely would be lower in St. Louis than in Nashville, the ROI might be better.

Another factor that can help determine the price for a secondary market property is the potential rent that can be charged. If rental rates are strong and are forecast to go up, you’ll probably pay more than you would for a property with weak rental rates and little upside.

Other factors affecting the price include:

• Location within a market. If the property is situated in a fast-growing, desirable swath of a city, the price likely will be higher than if it’s in a part of a city that’s being redeveloped.
• Building class (A, B or C, for example). Class A buildings command the highest prices, then Class B, then Class C.
• Amenities. An amenity-rich property, such as one with an abundance of parking, generally comes at a higher price.

Real estate investors would be wise to consider properties in secondary markets for their portfolios. Why? Partly because of the explosive growth of many of the country’s secondary markets and the potentially long-term shift away from primary markets. But as with any type of property purchase, investors must do their due diligence to ensure a secondary market is ripe for growth and an asset isn’t overpriced.

Contact Broadmark for your secondary market investment capital needs.